Has the Dollar Become A Risky Asset?

Investors who viewed the dollar as a haven for years are looking at the greenback differently.

The strengthening U.S. economy has fueled expectations this year the Federal Reserve may start taking its foot off the accelerator soon. At the same time, the dollar has started moving in step with assets that are typically seen as more risky, such as equities. Thursday’s price action offers a clear example. The dollar is down against the euro and pound, and the WSJ Dollar Index is off 0.66%, just as the Dow Jones Industrial average has slipped 1.5%.

That’s a big change from recent years. Throughout the financial crisis and the slow economic recovery that followed, whenever waning investor confidence triggered a sell-off in risky assets such as stocks and high-yield bonds, the dollar tended to rally as traders parked money in the perceived safety of the U.S. Investors sold stocks and the dollar together on Thursday in response to labor and housing reports that pointed to continued economic recovery, raising concern the Fed may start winding down its stimulus as early as next month.

“The dollar is making the transition away from the safe haven currency role it enjoyed the last four or five years to a pro-growth currency,” said Paresh Upadhyaya, director of currencies and a portfolio manager at Pioneer Investments in Boston, which has $216 billion in assets. “The price action we’re seeing today is a reflection that the dollar has undergone that transition.”

It’s not just the dollar that’s changed its behavior. The improving U.S. economy and expectations for a pullback in monetary stimulus from the Fed have led to a broad breakdown in many of the trading patterns that have dominated for years. The near-uniform move back and forth between risky assets and safe havens, known as the risk-on/risk-off trade, was nowhere to be found Thursday. Strong data in the U.S. and U.K. left traditional havens such as the dollar, Treasurys, German Bunds and U.K. Gilts out of favor. But the assets investors usually target when they’re feeling more bullish about growth, such as the higher yielding Australian dollar and equities, also fell.

The conflicting themes in part reflect expectations the central bank actions that have driven markets since the start of the financial crisis are beginning to recede into the background, which may allow different assets to trade on their own fundamentals.

“These markets have been morphing quite a bit,” said Axel Merk, head of Merk Investments, which has $500 million in assets. “Investors have to start thinking.”

For the dollar, that may ultimately be a positive development, Mr. Upadhyaya says. He’s betting the greenback will eventually rise versus the euro and yen. Once markets have a chance to fully digest the Fed’s decision on tapering its bond purchases, risky assets will start to perform well again, he said.

“If the Fed feels confident that they can now start to gradually tighten policy, that’s a good sign,” Mr. Upadyaya said.